On October 9, 2019, the Internal Revenue Service (IRS) issued Revenue Ruling 2019-24, which describes when a "hard fork" results in adverse tax consequences, and a set of frequently asked questions (the FAQs), which provide additional guidance that more generally addresses transactions involving virtual currency (a category that includes cryptocurrencies and forms of convertible virtual currency, such as bitcoin) for taxpayers that hold virtual currency as a capital asset.

Building on Prior Guidance

The IRS indicated in a news release that Rev. Rul. 2019-24 and the FAQs were intended to supplement the guidance the IRS had previously issued on transactions involving virtual currency in Notice 2014-21 and that it was soliciting public input on additional guidance in this area.¹ In Notice 2014-21, the IRS applied general tax principles to determine that virtual currency is property for U.S. federal income tax purposes and explained, in the form of a series of frequently asked questions, the application of general tax principles to the most common transactions involving virtual currency.

Rev. Rul. 2019-24

Under Rev. Rul. 2019-24, if the distributed ledger (such as a blockchain) of a cryptocurrency undergoes a hard fork which results in the creation of a new cryptocurrency and a holder of the original cryptocurrency receives units of the new cryptocurrency in connection with the hard fork by means of an "air drop," then the holder has ordinary income as a result. Rev. Rul. 2019-24 indicates that the amount of the ordinary income inclusion is the fair market value of the new units of cryptocurrency received and that the inclusion should be reported for U.S. federal income tax purposes in the taxable year during which the air drop is recorded on the distributed ledger.

However, Rev. Rul. 2019-24 suggests that the holder is not required to include such amount until the holder has "dominion and control" over the new units of cryptocurrency. For this purpose, Rev. Rul. 2019-24 indicates that a holder would not be considered to have dominion and control if the address to which the cryptocurrency is airdropped is contained in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange does not support the newly-created cryptocurrency such that the airdropped cryptocurrency is not immediately credited to the holder's account at the cryptocurrency exchange. If the holder later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the holder is treated as receiving the cryptocurrency at that time. In the case of such an airdrop, the holder would have a basis in the new cryptocurrency equal to the fair market value of the units received. On the other hand, if a hard fork does not result in the creation of a new cryptocurrency, then Rev. Rul. 2019-24 indicates that no adverse tax consequences result from the hard fork.

FAQs

As noted above, FAQs were issued in connection with Rev. Rul. 2019-24, which address transactions involving virtual currency more generally. The FAQs describe virtual currency as "a digital representation of value, other than a representation of the U.S. dollar or a foreign currency ('real currency'), that functions as a unit of account, a store of value, and a medium of exchange." As noted above, the FAQs indicate that virtual currency includes cryptocurrencies and digital currencies, and they caution that, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for U.S. federal income tax purposes, regardless of the label given to the asset.

The FAQs confirm several points raised in IRS Notice 2014-21, the only formal guidance concerning virtual currency that has been previously issued by the IRS to date, including the following:

• virtual currency is treated as property for U.S. federal income tax purposes;
• the general tax principles applicable to property transactions are also applicable to transactions involving virtual currency;
• capital gain or loss must be recognized when virtual currency is sold or exchanged for real currency, property, or services (subject to any applicable limitations on the deductibility of capital losses);
• employees and independent contractors that receive virtual currency as compensation for services must include the fair market value of the virtual currency received (measured in U.S. dollars as of the date of receipt) as ordinary income, and such income constitutes wages for employment tax purposes (in the case of employees) and self-employment income that is subject to self-employment tax (in the case of independent contractors); and
• the payor of the virtual currency described in the previous bullet is generally treated as having exchanged a capital asset for such services and will have a capital gain or loss as a result.

In addition, the FAQs provide some new points of guidance, including the following:

• if a taxpayer transfers property in an arm's length transaction and the taxpayer receives virtual currency in the exchange, the taxpayer's basis in such virtual currency is the fair market value of the virtual currency (in U.S. dollars) when the virtual currency is received;
• the fair market value of cryptocurrency received in a transaction facilitated by a cryptocurrency exchange is amount that is recorded by the cryptocurrency exchange for that transaction in U.S. dollars when such information is recorded;
• for a transaction facilitated by a cryptocurrency exchange that is not recorded on a distributed ledger or is otherwise considered an "off-chain" transaction, the fair market value of cryptocurrency received is the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an "on-chain" transaction;
• for a "peer-to-peer" transaction or other type of transaction involving virtual currency but that did not involve a cryptocurrency exchange, the fair market value of any cryptocurrency received is the amount the cryptocurrency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an "on-chain" transaction;
• taxpayers seeking to establish the fair market value of a virtual currency that does not have a published value may rely on the value as determined by a cryptocurrency or blockchain explorer that analyzes worldwide indices of a cryptocurrency and calculates the value of the cryptocurrency at an exact date and time, and if an explorer value is not available, then the taxpayer must establish that the value used for the cryptocurrency is an accurate representation of the cryptocurrency's fair market value;
• the taxpayer's holding period for a unit of virtual currency begins the day after it is received;
• a "soft fork" generally does not result in adverse U.S. federal income tax consequences;
• a taxpayer may transfer virtual currency from one wallet, address, or account belonging to the taxpayer to another wallet, address, or account that also belongs to the taxpayer without incurring adverse U.S. federal income tax consequences, even if the taxpayer receives an information return from an exchange or platform as a result of the transfer; and
• taxpayers that engage in a taxable transaction involving virtual currency but do not receive a payee statement or information return (such as a Form W-2 or Form 1099) must report any income, gain, or loss from the transaction on the taxpayer's U.S. federal income tax return for the taxable year of the transaction.

For further information, please contact Greg Broome (gbroome@wsgr.com, 415-947-2139) or any member of the tax practice at Wilson Sonsini.

---